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Loans comprise the most important asset as well as the primary source of earning for the banking
financial institution. On the other hand, this (loan) is also the major source of risk for the bank
management. A prudent bank management should always try to make an appropriate balance
between its in return and risk involved with the loan portfolio. An unregulated banking financial
institution might be fraught with unmanageable risks for the purpose of maximizing its potential
return. In such a situation, the banking financial institutions might find itself in serious financial
distress instead of improving its financial health. Consequently, not only the depositors but also
the general shareholders will be deprived of their money from the bank. The deterioration of loan
quality also affect the intermediary efficiency of the financial institutions and thus the economic
growth process of the country. This is the reason for which the banking financial institutions are
being regulated in all countries. The banking financial institutions are also the most regulated
among all types of financial institutions in all countries, because of their substantial role in the
payment mechanism (in addition to protecting the loan portfolio from decaying). But in the view
point of reformation the above regulations are being changed to match with the global and
situational requirements. Even credit risk grading system is changed in 2006 and introduced
since 1st April,2006. Its impact is not still evaluated. As a student of finance I find interest to
conduct a study on the topic.
TABLE OF CONTENTS
PAGE
CHAPTER ONE
1. I N T R O D U C T I O N
1.1 PRELUDE
1.2. BACKGROUND OF THE STUDY
1.3 Objectives of the study
1.4 Scope of the study
1.5 Methodology of the study
1.6 Limitations of the Study
9
11
14
15
15
16
CHAPTER TWO
2.0 LITERATURE REVIEW
2.1 Historical Background
2.2 Characteristics Of Central Bank
2.3 Nature Of Central Banking
2.4 Comparison between Central Banking and Commercial Banking
2.5 Functions Of A Central Bank
17
17
17
18
19
22
CHAPTER THREE
3.1 BANGLADESH BANK
3.2 Objectives of Bangladesh Bank
3.3 Function Of Bangladesh Bank
3.3.1 General Function / Activities
3.3.2 Controlling Activities
3.3.3 Promotional Activities
3.4 Role Of Bangladesh Bank
Interest rates
CRR
SLR
Bank Rate
EDF
3.5 CAMEL RATING
3.6 Management of Bangladesh Bank
3.6.1 Board of Directors
27
27
30
30
31
32
33
37
38
39
39
39
37
44
44
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
45
46
47
49
50
51
53
CHAPTER FOUR
4.1.Definition of Credit Risk Grading
4.2. Functions of Credit Risk Grading
4.3. Use of Credit Risk Grading
4.4. Number And Short Name Of Grades Used In The CRG
4.4.1 GRADES OF CRG
a). Superior
b). Good
c). Acceptable
d). Marginal/Watchlist
e). Special Mention
f). Substandard
g). Doubtful
h). Bad & Loss
54
55
56
57
58
58
59
59
60
60
61
61
61
CHAPTER FIVE
5.1 CREDIT RISK GRADING PROCESS
5.2 EARLY WARNING SIGNALS (EWS)
5.3 EXCEPTIONS TO CREDIT RISK GRADING
5.4 CREDIT RISK GRADING REVIEW
5.5 MIS ON CREDIT RISK GRADING
5.6 FINANCIAL SPREAD SHEET
APPENDIX-A
APPENDIX-B
APPENDIX-C
APPENDIX-D
APPENDIX-E
62
64
66
67
68
68
69
70
72
76
78
CHAPTER SIX
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
83
84
86
86
87
88
90
CHAPTER SEVEN
7.1. CREIDT RISK MANAGEMENT IN PAKISTAN
Components of credit risk management
Board and Senior Managements Oversight
Organizational Structure
Systems and Procedures of Credit Origination
Limit setting
Credit Administration
91
91
91
93
95
96
96
97
98
99
Risk review
101
101
101
102
103
103
104
105
105
106
106
106
106
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
106
106
108
108
110
110
110
110
CHAPTER EIGHT
111
115
122
CHAPTER. NINE
123
123
123
124
124
125
125
125
127
ANNEXURE
ABBREVIATION
Bibliography
Websites
128
130
130
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
CHAPTER ONE
INTRODUCTION
1.1 PRELUDE
Bangladesh Bank, the Central Bank of the country, pursued liberal monetary policy since
Independence mainly for reconstruction and rehabilitation requirements. In 1974/1975 under
inflationary pressure the measures were shifted to tight monetary policy, interests rates were
restructured, bank rate was enhanced, and Tk. 100 denomination was demonetized. From late
1970 to late 1980 liberal monetary policy was pursued once again. The policy package included
administered interest rate, Credit ceiling and directed credit programs, combined with generous
refinancing facilities on loans to priority sectors. Most of the nationalized commercial banks and
DFIs faced massive loan defaults, financial losses and erosion of their capital base.
In this backdrop, the Government in 1986 appointed a National Commission on Money, Banking
and Credit with representatives from Bangladesh Bank to prepare recommendations for financial
sector More over, in order to make necessary recommendations to ensure proper management
and to improve efficiency of the nationalized banks, and especially to create better environment
for smooth disbursement and recover of loans, a high level Task Force was set up. Consecutive
divesting floods of 1987 and 1988, and other national calamities created some problems for
monetary authority. The credit measures had to be liberal to ensure unhindered production
process in the agriculture and industrial sectors. In the field of agriculture credit disbursement
and repayment periods were rescheduled and TK 100 core agriculture loan program was
launched. Special credit program was adopted for rehabilitation of the industrial sector and
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
interference of the central bank in loan sanction/ rescheduled. In the light of recommendations
presented by the National Commission on Money, Banking and Credit and on the basis of an
IDA study, Bangladesh Bank on behalf of the Government formulated a program of Financial
Sector. The main objective of the Financial Sector Reform Program (FSRP) is to ensure a more
effective role of banking sector in supporting the countrys development programs, and in
mobilization and allocation of resources. The desired objective of the FSRP is expected to be
achieved through:
a) Adoption of a flexible market oriented interest rate policy for gradual removal of the
allocative efficiency of scare financial resources.
b) Providing incentives for lending to priority sectors and making subsidies in these sectors
explicit and transparent.
c)
d) Putting the banking sector on a sound financial footing by restructuring the capital and
establishing appropriate accounting principles of banks, and strengthening Central Banks
supervisory and regulatory role in the banking system.
e) Improving of loans through establishment of efficiency recovery procedures and stricter
legal environment and
f) Improving the capital market of the country.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
The ultimate aim of the FRSP is to gradually move towards a market- oriented competitive
economy, ensuring thereby a larger role of the private sector. Several Reform for improvement of
loan and making proper loan classification procedure been introduced. Bangladesh Bank has
changed loan classification procedure to place primary responsibility for classification on the
banks and focus bank inspection attention on monitoring these classifications. Bangladesh Bank
introduced new loans grading system named Credit Risk Grading Manual since 1st April 2006.
1.2.
Credit risk grading is an important tool for credit risk management as it helps the Banks &
financial institutions to understand various dimensions of risk involved in different credit
transactions. The aggregation of such grading across the borrowers, activities and the lines of
business can provide better assessment of the quality of credit portfolio of a bank or a branch.
The credit risk grading system is vital to take decisions both at the pre-sanction stage as well as
post-sanction stage.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
At the pre-sanction stage, credit grading helps the sanctioning authority to decide whether to lend
or not to lend, what should be the loan price, what should be the extent of exposure, what should
be the appropriate credit facility, what are the various facilities, what are the various risk
mitigation tools to put a cap on the risk level.
At the post-sanction stage, the bank can decide about the depth of the review or renewal,
frequency of review, periodicity of the grading, and other precautions to be taken.
Having considered the significance of credit risk grading, it becomes imperative for the banking
system to carefully develop a credit risk grading model which meets the objective outlined
above.
The Lending Risk Analysis (LRA) manual introduced in 1993 by the Bangladesh Bank has been
in practice for mandatory use by the Banks & financial institutions for loan size of BDT 1.00
crore and above. However, the LRA manual suffers from a lot of subjectivity, sometimes creating
confusion to the lending Bankers in terms of selection of credit proposals on the basis of risk
exposure. Meanwhile, in 2003 end Bangladesh Bank provided guidelines for credit risk
management of Banks wherein it recommended, inter alia, the introduction of Risk Grade Score
Card for risk assessment of credit proposals.
Since the two credit risk models are presently in vogue, the Governing Board of Bangladesh
Institute of Bank Management (BIBM) under the chairmanship of the Governor, Bangladesh
Bank decided that an integrated Credit Risk Grading Model be developed incorporating the
significant features of the above mentioned models with a view to render a need based simplified
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
10
and user friendly model for application by the Banks and financial institutions in processing
credit decisions and evaluating the magnitude of risk involved therein.
Bangladesh Bank expects all commercial banks to have a well defined credit risk management
system which delivers accurate and timely risk grading. This manual describes the elements of an
effective internal process for grading credit risk. It also provides a comprehensive, but generic
discussion of the objectives and general characteristics of effective credit risk grading system. In
practice, a banks credit risk grading system should reflect the complexity of its lending activities
and the overall level of risk involved.
Bangladesh financial system has started adopting wide ranging reform measures with a view to
enforcing financial discipline and improving financial efficiency.
ii)
Loan insiders and Connected Parties (The Companies Act-1991 with amendments).
iii)
iv)
v)
vi)
vii)
x)
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
11
xi)
xii)
Bankruptcy Act-1997.
But in the view point of reformation the above regulations are being changed to match with the
global and situational requirements. Even credit risk grading system is changed in 2006 and
introduced since 1st April,2006. Its impact is not still evaluated.
1.3 Objectives of the report
The objectives of the study are:
a) To identify the different forms of bank credit in Bangladesh
b) To familiarize with techniques of selecting the borrowers.
c) To familiarize with techniques of credit appraisal methods.
d) To familiarize with various operational procedure.
e) To provide reliable financial information about economic resources and obligations of an
enterprise.
f) To identify the ways and means for improving the quality of loan portfolio and
operational efficiency in banks
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
12
issue is multidimensional and vital. So, the study is limited on the Manuals, Acts, Off-site
Reports, Forms used by Banks and etc.
Survey of Literature
Primary
Data
Secondary
Collection of data
Data
Analyzing of data
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
13
Borrowers are not interested to supply any data and information about their loans
advances taken from the banks.
Sylhet is a deposit oriented but not invested oriented area. So the primary data about impact
of bank credit is not sufficiently available.
5.
CHAPTER---TWO
LITERATURE REVIEW
2.1 Historical Background
According to Will Rogers, there have been three great inventions since the beginning of time:
fire, the wheel and central banking. Although it might be seriously doubted if central banking
could be ranked so high, it can hardly be questioned that a central bank occupies a central or
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
14
pivotal position in the monetary and banking structure of the country in which it operates. To
meet the objective of monetary management, within the national framework, central banking has,
of late, achieved a new dignity and status which it had certainly not possessed before.
The above stated functions of a central bank clearly justify its need and importance. In the words
of Kent, As the special powers of the central banks are designed to enable it to control the
volume of hand-to-hand money and bank credit available in the country, it may be defined as an
institution which it charged with the responsibility of managing the expansion and contraction of
the volume of money in the interests of the general public welfare.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
15
2. A central bank acts as the lender of the money market and supervises, controls, and
regulates the activities of the commercial banking system:
A central bank is recognized as the apex monetary institution or the highest financial
authority whose main objective is to help, control and stabilize the monetary and banking
system of the country in the national economic interest. As bankers bank it confines the
major part of the activities to transactions with other baking institutions. The central bank
must be in a position to control the size of bank reserves as a means of controlling the
volume of money in circulation.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
16
3. There must always be a close working relationship between the central bank and the
national government: Although the central bank is normally endowed with the capacity
to regulate the volume of bank notes and demand deposits; that capacity is subject to the
policy and the actions of the government. The government now hardly be expected to
surrender their power of policy formulation to the central banks. The latter can serve a
useful purpose if it is accepted as the principal financial adviser to the Government. In the
words of Kent, A close working relationship must continuously exist between the two
institutions, so that one will not embark upon a course of action in direct conflict with
aims and objectives of the other.
Both the central bank and the commercial banks are basically monetary institutions. Both
deal money in one form or the other. The central bank creates money, whereas the
commercial banks deal in money. The central bank creates credit when it issues paper
currency without keeping securities of equivalent value in reserves. Likewise, the
commercial banks also create credit on the basis of their derivative deposits. Both the
institutions extend short term loans only because this helps them in maintaining liquidity
in their resources. But the similarities end here. A central bank is an organization with a
distinct entity and with functions different from those of commercial banks.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
17
The central bank is different from commercial banks in the following respects:
1. the central bank is the apex institution of the monetary and banking system of the
country. It controls the monetary system and the overall credit operations of the
banks. On the contrary, the commercial bank is only a constituent unit of the banking
system which is subordinate to the central bank.
2. the central bank posses the monopoly of note-issue. There was a time when certain
commercial banks also used to issue notes. This right is no longer held by commercial
banks now.
3. the central bank is not a profit making institution. Its main concern is to promote the
general economic policy of the government. It acts only in the public interest without
regard to profit as a primary consideration. As against this, the primary objective of
commercial banks is to earn profits for its share-holders.
4. The central bank maintains the foreign exchange reserves of the country and attempts
to maintain the stability in the exchange rates. The commercial banks only deal in
foreign exchange under the directions of the central bank. They do not have the
responsibility of maintaining the foreign exchange reserves and stability in exchange
rates.
5. the central bank is normally owned by the state, while commercial banks are mostly
privately owned. State ownership of commercial banks is not considered to be as
much essential as that of the central bank.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
18
6. the central bank does not deal directly with the public. The central bank mainly deal
with the government and the banking institutions. Hence, it cannot undertake the
functions normally performed by the commercial banks.
7. the central bank is closely related to the government as its banker and the financial
adviser. It is generally an organ of the government and its actions are closely
coordinated with those of the other departments, particularly with the department of
finance or the treasury. Commercial banks on the other hand act as bankers and
advisers to the general public only.
8. the central bank has a special relation with the commercial banking system of the
country. It is given special powers to control, supervise and regulate the working of
the latter. The commercial banks are required to act in accordance with the directives
issued by the central bank.
9. the central bank functions as a bankers bank. As a lender of the last resort, it provides
rediscounts and advances to the commercial banks in times of credit stringency. It
also performs the clearing house functions for the benefit of banking system.
Commercial banks maintain their cash reserves and deposits with the central banks.
10. the central bank does not compete with the central banks. If the central banks were to
compete with the commercial banks, it would be departing from its functions as the
bankers bank and as a lender of the last resort. The commercial banks, on the other
hand, are likely to compete with each other in order to maximize their business and
profits.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
19
The performance of various functions by a central bank is based on its powers with respect to
the issuance of notes, its powers as controller of banking reserves, and its position as principal
financial adviser of the national government.
1. Bank of Issue: The issue of paper money is the most important function of the central
bank. In fact, the privilege of note issue was almost everywhere associated with the origin
and development of central banks. Central bank is known as the bank of issue until the
beginning of the twentieth century.
De kock has mentioned four reasons for the concentration of note issue in a
central bank. These are:
(1) Uniformity in note circulation to attain effective state supervision;
(2) Control over undue credit expansion by the commercial banks.
(3) To give distinctive prestige to the note issue, which is of immense value
particularly during a crisis; and
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
20
(4) To provide for participation of the state in the profits of the central bank.
3.
4. Custodian of the cash reserves of the commercial banks: The commercial banks in
the country keep a part of their cash balances s deposits with the central bank, either
voluntarily because of convention or because of some legal obligation. The central bank
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
21
function of holding the cash reserves of commercial banks is so important that many of
the central banks have come to be called as Reserve Banks.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
22
7. Controller of Credit:
The control of credit is considered to be the main function of a central bank. De Kock
observes, it is the function which embraces the most important questions of central
banking policy and the one through which practically all the other functions are united
and made to serve a common purpose. The central bank purpose of note issue, the
management of government accounts, the custody of commercial banks cash reserves,
along with those of rediscount and the lender of the last resort, are requires centralized
control over both currency and credit.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
23
In a developing country, particularly, the central bank has important roles to play in the
process of development. The under developed economies have under developed money
markets where banking system is not properly organized. There are institutional gaps in
the money and capital markets which hinder economic growth. Thus promotion of sound,
organized, well integrated institutions and agencies of money and capital markets
becomes the important function of a central bank in a developing economy.
CHAPTER---THREE
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
24
As the central bank of the country the objectives of Bangladesh Bank, as outlined in the
Bangladesh Bank Order 1972 are:
a. To regulate the issue of currency and the keeping of reserves;
b. To manage the monetary and credit system of Bangladesh with a view to stabilizing
domestic monetary value;
c. Preserving the par value of Bangladesh Taka;
d. Promoting and maintaining a high level of production, employment and real income in
Bangladesh and
e. Fostering growth and development of our productive resources in the best national
interest.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
25
To manage the monetary and credit system of Bangladesh with a view to stabilizing
domestic monetary value. Bangladesh Bank regulates and manages the monetary and credit
systems of the country as the guardian of the money market through its monetary policy
instruments like bank rate, reserve requirement for the scheduled banks, open market
operation, directed lending, moral persuasion etc. One of the aims of the monetary policy is
to contain the inflation at a reasonable level
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
26
The role of Bangladesh Bank on the above three objectives are traditional for a central
bank. But the role of the Bangladesh Bank in achieving following objectives discussed
below are developmental ones.
d) Promoting and maintaining a high level of production, employment and real income in
Bangladesh.
The aim of the monetary policy pursued by Bangladesh Bank is to increase production,
employment and real income. Bangladesh Bank directs commercial banks to lend to the priority
sector of the economy at a concessional rate. It also releases fund for development activities.
Side by side, Bangladesh Bank also tries to keep the purchasing power of the people through its
monetary policy, so that real income of the people be increased or maintained.
e) Fostering growth and development of our productive resources in the best national
interest.
Bangladesh Bank, in close cooperation with the Government, releases funds for various
developmental projects and also ensures timely disbursement of fund for successful
implementation of the projects. Bangladesh Bank does also have its own projects in the field of
agriculture. Functions of Bangladesh Bank are also to research on economic condition of
Bangladesh, publish data on economic matters and advise the Government on its policy
formulation. Bangladesh Bank also plays a vital role to promote foreign trade of our country and
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
27
remove Balance of Trade difficulties through its foreign exchange policies. So by these ways
Bangladesh Bank foster the growth and development of our productive resources.
In order to achieve the objectives general function of Bangladesh Bank are as follows:
1. Issuance of notes: Ensure note circulation throughout the country to facilitate trade and
commerce. It maintains currency chest in 66 places throughout the country through
Sonali Bank.
2. Banker to other Banks: Receive statutory cash reserve requirement and extends loans to
the scheduled Banks. Often refinance, rediscounting facilities etc are provide to
scheduled Banks.
3. Banker to the Government: Accept money deposit without interest from the
Government and collection of money for the Government from local authorities, banks
and other persons. It also extends loans to Govt under ways and means head.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
28
4. Lender to the last resort : Through purchase, Sale and rediscount of Bill of exchange,
Promissory note, Treasury bills and Lending to the scheduled banks when required.
5. Clearing House facilities: Extends clearing house facilities to settle transactions between
member banks.
1. Credit Control: Formulate credit norms, restrict credit and facilitate credit to any specific
sector for national interest.
2. Formulation of monetary policy: Determine Bank rate, setting of interest rate on deposits
and investment, open market operation, credit restriction, statutory cash reserve
requirement, fixing minimum paid up capital requirement for a scheduled bank.
3. Foreign exchange regulation and liberalization: To ensure sufficient reserve of foreign
exchange, facilitate import business of the country and to restrict illegal outflow of
foreign.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
29
It involves creation, promotion and maintenance of high level of production employment and
real income in Bangladesh. It is done through monetary policy, in the form of credit restrictions,
offering subsidy and participating with commercial banks in developing / uplifting of economic
activities through rural credit disbursement etc. Participation in promotional activities are as
follows:
Bangladesh Bank, the Central Bank of the country, pursued liberal monetary policy since
Independence mainly for reconstruction and rehabilitation requirements. In 1974/1975 under
inflationary pressure the measures were shifted to tight money policy, interests rates were
restructured, bank rate was enhanced, and Tk. 100 denomination was demonetized. From late
1970 to late 1980 liberal monetary policy was pursued once again. The policy package included
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
30
administered interest rate, Credit ceiling and directed credit programs, combined with generous
refinancing facilities on loans to priority sectors. Most of the nationalized commercial banks and
DFIs faced massive loan defaults, financial losses and erosion of their capital base. In this back
drop, the Government in 1986 appointed a National Commission on Money, Banking and Credit
with representatives from Bangladesh Bank to prepare recommendations for financial sector
More over, in order to make necessary recommendations to ensure proper management and to
improve efficiency of the nationalized banks, and especially to create better environment for
smooth disbursement and recover of loans, a high level Task Force was set up. Consecutive
devastating floods of 1987 and 1988, and other national calamities created some problems for
monetary authority. The credit measures had to be liberal to ensure unhindered production
process in the agriculture and industrial sectors. In the field of agriculture credit disbursement
and repayment periods were rescheduled and TK 100 core agriculture loan program was
launched. Special credit program was adopted for rehabilitation of the industrial sector and
interference of the central bank in loan sanction/ rescheduled. In the light of recommendations
presented by the National Commission on Money, Banking and Credit and on the basis of an
IDA study, Bangladesh Bank on behalf of the Government formulated a program of Financial
Sector. The main objective of the Financial Sector Reform Program (FSRP) is to ensure a
more effective role of banking sector in supporting the countrys development programs, and in
mobilization and allocation of resources. The desired objective of the FSRP is expected to be
achieved through:
a. Adoption of a flexible market oriented interest rate policy for gradual removal of the
allocative efficiency of scare financial resources.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
31
b. Providing incentives for lending to priority sectors and making subsidies in these sectors
explicit and transparent.
c. Promoting better monetary management by moving towards flexible and indirect
instruments of monetary control.
d. Putting the banking sector on a sound financial footing by restructuring the capital
and establishing appropriate accounting principles of banks, and strengthening Central
Banks supervisory and regulatory role in the banking system.
e. Improving of loans through establishment of efficiency recovery procedures and
stricter legal environment and
f. Improving the capital market of the country.
g. The ultimate aim of the FRSP is to gradually move towards a market- oriented
competitive economy, ensuring thereby a larger role of the private sector. Several
reform for improvement of loan and making proper loan classification procedure been
introduced. Bangladesh Bank has changed loan classification procedure to place primary
responsibility for classification on the banks and focus bank inspection attention on monitoring
these classifications. Bangladesh Bank introduced new loans grading system named Credit Risk
Grading Manual since 1st April 2006.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
32
Here in the following table the average interest rate on deposits and advances of Scheduled Bank
from financial year 2002 to 2006 is shown:
Table-1
Area of Interest
Interest rate on Deposits.
Interest rate on Advances.
Spread of Interest rate.
2002
6.7
13.2
6.5
2003
6.3
12.8
6.5
After June
2004
2005
5.7
5.6
11.0
10.9
5.3
5.3
2006
6.7
12.1
5.4
From table above it may be considered that the interest rate and the spread of interest rate is
decreasing gradually.
33
Bank Rate:
The bank rate remained unchanged at 5% in FY06. This rate has been in effect since 6 November
2003.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
34
C=Capital Adequacy
A=Asset Quality
M=Management
E=Earning
L=Liquidity
Each of the dimensions is rated on a scale of 1 through 5 and a composite rating is accorded to
each bank calculated on the basis of the evaluation of specific performance of each dimension
/component.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
35
Under the Financial Sector Reform Project (FSRP) Bangladesh Bank started off-site
supervision using CAMEL Rating analysis in 1993. Using data provided by the banks.
Bangladesh Bank determine the CAMEL rating through the analysis of the five
dimensions mentioned earlier. Through the analysis of CAMEL rating DBOD of
BANGLADESH BANK identifies financial weakness of scheduled banks and issues
necessary instructions to concern banks for the corrections of those weaknesses.
On the other hand, in the process of preparing comprehensive report on the head office
inspection, Bangladesh Bank (DBI) accord CAMEL rating on each bank through the
guidelines of Inspection Manual. Through the composite rating is not disclosed to the
inspected bank. The bank is asked to provide clear written explanation on the problems
identified with each component of the CAMEL.
Main considering factors and reasons for the consideration of components of CAMEL
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
36
Risk
0%
50%
Weight
100%
50%
RWA
100TK
50TK
150TK
Core capital is considered on qualitative judgment (4% core capital to RWA is acceptable).
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
37
Management (M):
Management itself has no rating. However it is determined on the average of rating
attributed to C, A, E, and L-------- M = C + A + E + L / 4
Earnings (E):
Main considerations--- Return of asset (ROA)
Return on equity (ROE)for qualitative judgement.
Net interest Margin (NIM) for qualitative judgement
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
38
Liquidity (L):
Main considerations--- Statutory liquid asset to total deposit
Other liquid and off balance sheet assets--- for qualitative judgement.
Main Reasons:
To see if the bank is dependent on borrowed money
To understand how the asset growth has been funded
Composite Rating:
Composite Rating is the summations of the ratings of all specific dimensions divided by 5 that is
= C +A+ M + E + L / 5
Example: if C=1, A=2, M=3, E=2 and L=2 then CAMEL= 1+ 2 + 3 + 2 + 2 / 5 = 2
CAMEL rating matrix in the context of Bangladesh:
Indicator
percentage
9% and above
8% but less Than 9%
7% but less Than 8%
6% but less Than 7%
5% but less Than 6%
Rating
1
2
3
4
5
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
39
Management (M)
Earning (E)
Liquidity (L)
3%
<3% to 5%
<6% to 10%
<10% to 1 5%
<15
1
2
3
4
5
M = C +A+ E + L/ 4
ROA 1.80%
ROA = 0.60% to 1.80%
ROA = 0.50%
ROA= 0.25%
ROA< 0.10%
25% to 30%
20%><25%
15%><20%
10%><15%
>10%
1
2
3
4
5
1
2
3
4
5
1
2
3
4
5
Ratings
1
2
3
4
5
Performance Status
Strong
Satisfactory
Fair
Marginal
Unsatisfactory
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
40
Strong (composite 1): The banks with such rating is sound in almost every aspect and
resistant to external economic and financial shocks.
satisfactory(composite 2): The banks with such rating are also fundamentally sound
institutions. However they may have some modest weakness, which are correctable in the
normal course of business.
fair(composite 3): the banks with such ratings reflects financial weakness. Corrections
of these weaknesses need routine checking.
Marginal(composite 4): Banks with such rating have a substantial amount of asset
weakness or a combination of other weakness. Prompt and effective financial and
administrative measures are needed at this stage.
unsatisfactory(composite 5) :Banks with such rating reflects critically deficit
performance and need immediate remedial attention. The probability of failure of such
banks is very high.
Note: Whenever any bank is rated as composite 4, Bangladesh bank declares that bank as
problem bank and brings that bank under intensive monitoring and supervision.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
41
The general superintendence and direction of the affairs and business of the Bank is entrusted to
a Board of Directors which exercise all the powers and does all the acts that may be exercised
and done by the Bank.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
42
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
43
Secretarys Department.
Department of Security Management.
Statistics Department.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
44
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
45
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
46
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
47
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
48
The success of any organization depends on its manpower. So the recruitment and management
of manpower is a very important task for any organization. The human Resource Department of
Bangladesh Bank is entrusted with the responsibilities of selection, recruitment, Promotion,
demotion, and transfer of the staff of the BB.
3.7.1 Recruitment :
There are three methods by which posts in different categories of staff can be filled in, viz.
By direct recruitment.
By promotion from one class to another or to a higher grade or appointment in the same
class and
By transfer from one cadre/ department/office to another.
Appointments to the service of the Bank shall be made by the Governor, subject to the approval
of the Board. Recruitment in the Bank is made through the competitive examination. In
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
49
recruiting the officers certain ratio for direct recruitment and promotion is maintained. The ratio
is determined by competent authority. At present one Assistant Director will be recruited for one
Assistant Director promoted from lower positions. In every two vacancies the first one will be
filled up by promotion and the second one by direct recruitment. This ratio of 1:.1 for direct
recruitment to promotion has been made effected from 1st January 2003.
Earlier in every three vacant posts of officers the first two posts were filled up by promotion and
the third one by direct recruitment. But at present the recruitment of clerical level has been
stopped. But employees in the post of Stenographer, Data Entry/ Control Operator, Telephone
Operators etc may be promoted to the post of officers after completion of certain years of
services. Now the ratio of direct recruitment to promotion is 9:1.
If suitable candidates are not available in for promotion and/or direct recruitment, the number of
vacant posts by quota may be carried over to the next year or even after that and may be filled in
by respective promotion and/or direct recruitment, as the case may be, by observing the
concerned formalities.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
50
Qualifications
a)
b)
Marks
i)
14
ii)
10
09
iv) H.S.C
07
DAIBB(Part 1& 2)
03+ 03 =
06
OF
DIRECTORS
GOVERNOR
DEPUTY
GOVERNOR
EXECUTIVE
DIDECTOR
GENERAL
MANAGER
DEPUTY
GOVERNOR
ECONOMIC
ADVISOR
GENERAL
MANAGER
EXECUTIVE
DIRECTOR
GENERAL
DEPUTY
GENERAL
MANAGER
DEPUTY
GOVERNOR
EXECUTIVE
DIRECTOR
GENERAL
MANAGER
SECRETARY
GENERAL
DEPUTY
GENERAL
MANAGER
DEPUTY
GENERAL MANAGER
CURRENCY
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
51
JIONT-Director
JIONT-Director
JOINT
MGR(CASH)
JIONT-Director
JIONT-Director
Dep-
DEPUTY
MANAGER
(CASH)
DepDIR
ASSISTANT
DIDECTOR
ASSISTANT
DIDECTOR
ASSISTANT
DIDECTOR
ASSISTANT
DIDECTOR
CHAPTER-----FOUR
ASSISTANT
DIDECTOR
ASSISTANT
MGR(HCAS))
OFFICER
(CASH)
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
52
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
53
Credit Risk Grading is the basic module for developing a Credit Risk Management
system.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
54
GRADING
Superior
Good
Acceptable
Marginal/Watchlist
Special Mention
Sub standard
Doubtful
Bad & Loss
SHORT NAME
SUP
GD
ACCPT
MG/WL
SM
SS
DF
BL
NUMBER
1
2
3
4
5
6
7
8
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
55
f) Sub-standard (SS)
g) Doubtful (DF)
h) Bad/ Loss (BL)
A clear definition of the different categories of Credit Risk Grading is given as follows:
a) Superior - (SUP) - 1
Credit facilities, which are fully secured i.e. fully cash covered.
Credit facilities fully covered by government guarantee.
Credit facilities fully covered by the guarantee of a top tier international Bank.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
56
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
57
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
58
Full repayment of principal and interest is unlikely and the possibility of loss is
extremely high.
However, due to specifically identifiable pending factors, such as litigation,
liquidation procedures or capital injection, the asset is not yet classified as Bad &
Loss.
Bangladesh Bank criteria for doubtful credit shall apply.
An Aggregate Score of 35-44 based on the Risk Grade Score Sheet.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
59
CHAPTER FIVE
Credit Risk Grading should be completed by a Bank for all exposures (irrespective of
amount) other than those covered under Consumer and Small Enterprises Financing
Prudential Guidelines and also under The Short-Term Agricultural and Micro - Credit.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
60
For Superior Risk Grading (SUP-1) the score sheet is not applicable. This will be
guided by the criterion mentioned for superior grade account i.e. 100% cash covered,
covered by government & bank guarantee.
Credit risk grading matrix would be useful in analyzing credit proposal, new or renewal
for regular limits or specific transactions, if basic information on a borrowing client to
determine the degree of each factor is a) readily available, b) current, c) dependable, and
d) parameters/risk factors are assessed judiciously and objectively. The Relationship
Manager as per Data Collection Checklist as shown in Appendix-A should collect
required information.
Relationship manager should ensure to correctly fill up the Limit Utilization Form as
shown in Appendix-B in order to arrive at a realistic earning status for the borrower.
Risk factors are to be evaluated and weighted very carefully, on the basis of most up-todate and reliable data and complete objectivity must be ensured to assign the correct
grading. Actual parameter should be inputted in the Credit Risk Grading Score Sheet as
shown in AppendixC.
Credit risk grading exercise should be originated by Relationship Manager and should
be an on-going and continuous process. Relationship Manager shall complete the Credit
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
61
Risk Grading Score Sheet and shall arrive at a risk grading in consultation with a Senior
Relationship Manager and document it as per Credit Risk Grading Form as shown in
Appendix-D, which shall then be concurred by the Credit Officer in consultation with a
Senior Credit Officer.
All credit proposals whether new, renewal or specific facility should consist of a) Data
Collection Checklist, b) Limit Utilization Form c) Credit Risk Grading Score Sheet, and
d) Credit Risk Grading Form.
The credit officers then would pass the approved Credit Risk Grading Form to Credit
Administration Department and Corporate Banking/Line of Business/Recovery Unit for
updating their MIS/record.
The appropriate approving authority through the same Credit Risk Grading Form shall
approve any subsequent change/revision i.e. upgrade or downgrade in credit risk grade.
Early Warning Signals (EWS) indicate risks or potential weaknesses of an exposure requiring
monitoring, supervision, or close attention by management.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
62
If these weaknesses are left uncorrected, they may result in deterioration of the repayment
prospects in the Banks assets at some future date with a likely prospect of being downgraded to
classified assets.
Early identification, prompt reporting and proactive management of Early Warning Accounts are
prime credit responsibilities of all Relationship Managers and must be undertaken on a
continuous basis.
Despite a prudent credit approval process, loans may still become troubled. Therefore, it is
essential that early identification and prompt reporting of deteriorating credit signs be done to
ensure swift action to protect the Banks interest. The symptoms of early warning signals as
mentioned below are by no means exhaustive and hence, if there are other concerns, such as a
breach of loan covenants or adverse market rumors that warrant additional caution, a Credit Risk
Grading Form (Appendix-D) should be presented.
Irrespective of credit score obtained by any obligor as per the proposed risk grade score sheet,
the grading of the account highlighted as Early Warning Signals (EWS) accounts shall have the
following risk symptoms.
a) Marginal/Watchlist (MG/WL - 4): if Any loan is past due/overdue for 60 days and above.
Frequent drop in security value or shortfall in drawing power exists.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
63
b) Special Mention (SM - 5): if Any loan is past due/overdue for 90 days and above
Major document deficiency prevails (such deficiencies include but not limited to; board
resolution for borrowing not obtained, sanction letter not accepted by client,
charges/hypothecation over assets favoring bank not filed with Registrar, Joint Stock
Companies, mortgage not in place, guarantees not obtained, etc.)
A significant petition or claim is lodged against the borrower.
The Credit Risk Grading Form of accounts having Early Warning Signals should be completed
by the Relationship Manager and sent to the approving authority in Credit Risk Management
Department. The Credit Risk Grade should be updated as soon as possible and no delay should
be there in referring Early Warning Signal accounts or any problem accounts to the Credit Risk
Management Department for their early involvement and assistance in recovery.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
64
In case an account is rated marginal, special mention or unacceptable credit risk as per
the risk grading score sheet, this may be substantiated and credit risk may be accepted if
the exposure is additionally collateralized through cash collateral, good tangible
collaterals and strong guarantees. These are exceptions and should be exceptionally
approved by the appropriate approving authority.
If a Bank has its own well established risk grading system equivalent to the proposed
credit risk grading or stricter, then they will have the option to continue with their own
risk grading system.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
65
Credit Risk Grading for each borrower should be assigned at the inception of lending and should
be periodically updated. Frequencies of the review of the credit risk grading are mentioned
below.
Number
1
2
3
4
5
6
7
8
Risk Grading
Superior
Good
Acceptable
Marginal/Watchlist
Special Mention
Sub-standard
Doubtful
Bad & Loss
Short
SUP
GD
ACCPT
MG/WL
SM
SS
DF
BL
Bank should have comprehensive MIS reports on credit risk grading to evaluate
entire credit portfolio of the Bank. Format of such MIS reports on credit risk grading
has been presented in Appendix - E.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
66
APPENDIX-A
DATA COLLECTION CHECK LIST
ABC BANK LIMITED- Dhanmondi Branch
DATA COLLECTION CHECK LIST
Documents/items required for Credit Risk Grading
Company accounts for at least 3 years
Required? Obtained?
YES
YES NO
NO
Bank statements for prior 12 months from previous bank (for new
customer)
Set of accounts for at least two competitors (if published)
Industry average figures (If available)
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
67
Responsibility
_________________________
Manager (RM)
Due Date
Status
__________
Relationship
Senior Relationship Manager (SRM)
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
68
APPENDIX-B
Date:
Period: For the Period from ----------- to -------------- (12 months Actual/Projected)
Account Performance:
Nature of the Account
Debit
Summation
Credit
Summation
N/A
X
X
N/A
N/A
N/A
N/A
N/A
X
X
N/A
N/A
N/A
N/A
Account Volume:
Facilities
Letter of Credits
Guarantees
Local/Export Bills Handled
X
X
X
X
X
X
X
Account Profitability:
Nature of
Account/Facility
Current Account
Overdraft/Cash Credit
SLC
Term Loan
Import Loan-Hypo
Demand Loan-Hypo
Guarantees
LBDP/Export Bills
Handled
Average Rate of
Utilization Interest
Interest
Income
X
X
X
X
X
X
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
69
Gross Earnings
Less: Cost of Fund
Net Earnings
XXX
XX
XXX
XXX
XXX
XXX
XXX
XXX
XX
XXX
Comment on Relationship/Earnings:
Our earnings from borrower for the last year was BDT------------- and from Group
BDT------Our projected earnings from borrower for the next year will be BDT------ and Group
BDT--Account Turnover and utilization of limit during the last year was satisfactory.
_________________________
__________________________
Relationship Manager (RM)
(SRM)
APPENDIX-C
Date:
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
70
Borrower:
Group Name (if
any):
Branch:
Industry/Sector:
Date of Financials:
Completed by:
Approved by:
Risk Grading:
Number
Grading
Short
Superior
SUP
2
3
4
5
6
7
8
Good
Acceptable
Marginal/Watchlist
Special Mention
Substandard
Doubtful
Bad & Loss
Criteria
A. Financial Risk
1. Leverage: (15%)
Weight
Parameter
50%
_________
Score
Actual
Score
Parameter Obtained
15
14
13
12
11
10
8
7
0
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
71
2. Liquidity: (15%)
Current Ratio () - Times
Current Assets to Current
Liabilities
3. Profitability: (15%)
Operating Profit Margin (%)
Operating Profit
100
Sales
4. Coverage: (5%)
Interest Coverage Ratio ()Times
Earning Before Interest & Tax
(EBIT)
Interest on debt
Criteria
Weight
B. Business/Industry
Risk
18%
1. Size of Business (Sales in BDT
crore)
15
14
13
12
11
10
8
7
0
15
14
13
12
10
9
7
0
5
4
3
2
0
50
Parameter
> 60.00
30.00 59.99
10.00 29.99
5.00 - 9.99
2.50 - 4.99
< 2.50
Score
Actual
Score
Parameter Obtained
5
4
3
2
1
0
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
72
2. Age of Business
5. Market Competition
6. Entry/Exit Barriers
> 10 years
> 5 - 10 years
2 - 5 years
< 2 years
3
2
1
0
Favorable
Stable
Slightly Uncertain
Cause for Concern
3
2
1
0
Strong (10%+)
Good (>5% - 10%)
Moderate (1% - 5%)
No Growth (<1%)
Dominant Player
Moderately Competitive
Highly Competitive
Difficult
Average
Easy
3
2
1
0
Criteria
C. Management Risk
Weight
12%
1. Experience
(Management & Management
Team)
Parameter
2
1
0
2
1
0
18
Score
Actual
Score
Parameter Obtained
5
3
2
0
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
73
3. Team Work
Ready Succession
Succession within 1-2
years
Succession within 2-3
years
Succession in question
Very Good
Moderate
Poor
Regular Conflict
4
3
2
0
3
2
1
0
12
Criteria
D. Security Risk
Score
Weight
10%
Parameter
Actual
Score
Parameter Obtained
4
3
2
1
0
4
3
2
1
0
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
74
3. Support (Guarantee)
Criteria
E. Relationship
Risk
1. Account Conduct
Weight
10% Parameter
2. Utilization of Limit
(actual/projection)
3. Compliance of
Covenants / Conditions
1
0
10
Score
Actual
Score
Parameter Obtained
5
4
2
0
2
1
0
2
1
0
4. Personal Deposits
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
75
APPENDIX-D
Branch:
Legal Status:
Business:
Risk
Existing
New
Grading
Next Grading Review Date:
Grade Score Existing
New
Credit Risk Grade Score Sheet Ref. No ----------------- & dated ---------------- enclosed.
Facilities
Amount in 000 TK
Limit Outstandings
Expiry/
Maturity
Days Past
due
Interest
Suspense
Provision
Held
SLC/PAD
LTR
ULC/Acceptance
Overdraft
Cash Credit
Demand Loan
Term Loan
Guarantee
Total
Key Financials
Period
Sales
Net Profit
Current Ratio (X)
Leverage (X)
Operating Profit/Sales (%)
Interest Coverage (X)
Query:
Are we receiving Financials regularly?
Monthly sales deposit receipt and adjustment by the Bank:
(For last 6 months.)
Is client in business?
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
76
_________________________
___________________
GRADING APPROVAL
Credit Officer, CRM
Senior
APPENDIX-E
MIS REPORTS ON CREDIT RISK GRADING
ABC BANK LIMITED
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
77
K GRADE
NUMBER
OF
BORROWE
R
IN %
LIMIT
(TK IN 000)
IN %
OUTSTAND
ING
(TK IN
000)
IN %
PERIOR - 1
OD - 2
CEPTABLE - 3
RGINAL/WATCHLIS
CIAL MENTION -
B STANDARD - 6
UBTFUL - 7
D & LOSS - 8
TAL
100%
100%
100%
K GRADE
NUMBER OF
BORROWER
IN %
LIMIT
(TK IN
000)
IN % OUTSTAND
ING
(TK IN
000)
IN %
100%
100%
PERIOR - 1
OD - 2
CEPTABLE - 3
RGINAL/WATCHLIST-
CIAL MENTION - 5
B STANDARD - 6
UBTFUL - 7
D & LOSS - 8
TAL
100%
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
AN
78
NUMBER OF
BORROWER
IN %
LIMIT
(TK IN
000)
IN % OUTSTAND IN %
ING
(TK IN
000)
NCIPAL SUPERIOR - 1
GOOD - 2
ACCEPTABLE - 3
MARGINAL/WATC
HLIST- 4
SPECIAL MENTION
-5
SUB STANDARD 6
DOUBTFUL - 7
BAD & LOSS - 8
b Total (Principal Branch)
RABAD SUPERIOR - 1
GOOD - 2
ACCEPTABLE - 3
MARGINAL/WATC
HLIST- 4
SPECIAL MENTION
-5
SUB STANDARD 6
DOUBTFUL - 7
BAD & LOSS - 8
b Total (Agrabad Branch)
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
79
NAME OF BORROWER
SUP- 1
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL SUPERIOR GRADE
CREDIT RISK GRADE:
BRANCH
NAME OF BORROWER
GD-2
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL GOOD GRADE
CREDIT RISK GRADE:
BRANCH
NAME OF BORROWER
ACCPT-3
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
80
AGRABAD
TOTAL ACCEPTABLE GRADE
NAME OF BORROWER
MG/WL-4
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL MARGINAL/WATCHLIST
GRADE
NAME OF BORROWER
SM-5
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL SPECIAL MENTION GRADE
CREDIT RISK GRADE:
BRANCH
NAME OF BORROWER
SS-6
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL SUB STANDARD GRADE
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
81
NAME OF BORROWER
DF-7
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL DOUBTFUL GRADE
CREDIT RISK GRADE:
BRANCH
NAME OF BORROWER
BL-8
LIMIT
OUTSTANDING CREDIT
(TK IN 000) (TK IN 000) EXPIRY
PRINCIPAL
AGRABAD
TOTAL BAD & LOSS GRADE
Chapter Six
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
82
The following step-wise activities outline the detail process for arriving at credit risk grading.
Step I
Financial Risk
Business/Industry Risk
Management Risk
Security Risk
Relationship Risk
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
83
Each of the above mentioned key risk areas require to be evaluated and aggregated to arrive at an
overall risk grading measure.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
84
Risk that the bank might be exposed due to poor quality or strength of the security in case
of default. This may entail strength of security & collateral, location of collateral and
support.
Step II
According to the importance of risk profile, the following weightages are proposed for
corresponding principal risks.
Weight:
Financial Risk
50%
Business/Industry Risk
18%
Management Risk
12%
Security Risk
10%
Relationship Risk
10%
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
85
Step III
Financial Risk
Business/Industry Risk
Key Parameters:
Outlook,
Barriers to Business
Management Risk
Security Risk
Relationship Risk
Conduct
,Utilization
Compliance of
covenants/conditions & Personal Deposit.
Step IV
Key Parameters:
Weight:
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
of
Limit,
86
Financial Risk
50%
Leverage
15%
Liquidity
15%
Profitability
15%
Coverage
5%
Business/Industry Risk
18%
Size of Business
5%
Age of Business
3%
Business Outlook
3%
Industry growth
3%
Market Competition
2%
Entry/Exit Barriers
2%
Management Risk
12%
Experience
5%
Succession
4%
Team Work
3%
Security Risk
10%
Security coverage
4%
Collateral coverage
4%
Support
2%
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
87
Relationship Risk
Account conduct
10%
5%
Utilization of limit
2%
Compliance of covenants
/condition
Personal deposit
Step V
2%
1%
After the risk identification & weightage assignment process (as mentioned above), the next steps
will be to input actual parameter in the score sheet to arrive at the scores corresponding to the
actual parameters.
This manual also provides a well programmed MS Excel based credit risk scoring sheet to arrive
at a total score on each borrower. The excel program requires inputting data accurately in
particular cells for input and will automatically calculate the risk grade for a particular borrower
based on the total score obtained. The following steps are to be followed while using the MS
Excel program.
a)
b)
The entire XL sheet named, CRG is protected except the particular cells to input data.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
88
c)
Input data accurately in the cells which are BORDERED & are colored YELLOW.
d)
Some input cells contain DROP DOWN LIST for some criteria corresponding to the Key
Parameters. Click to the input cell and select the appropriate parameters from the DROP
DOWN LIST as shown below.
e)
All the cells provided for input must be filled in order to arrive at accurate risk grade.
f)
We have also enclosed the MS Excel file named, CRG_Score_Sheet in CD ROM for use.
Step VI
The following is the proposed Credit Risk Grade matrix based on the total score obtained by an
obligor.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
89
Number
1
Risk Grading
Superior
Short Name
SUP
2
3
Good
Acceptable
4
5
6
7
8
Marginal/Watchlist
Special Mention
Sub-standard
Doubtful
Bad & Loss
Score
100% cash covered
Government guarantee
International Bank
GD
ACCPT
guarantees
85+
75-84
MG/WL
SM
SS
DF
BL
65-74
55-64
45-54
35-44
<35
CHAPTER=FIVE
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
90
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
91
2.2.3 The very first purpose of banks credit strategy is to determine the risk appetite of the bank.
Once it is determined the bank could develop a plan to optimize return while keeping credit risk
within predetermined limits. The banks credit risk strategy thus should spell out
a) The institutions plan to grant credit based on various client segments and products, economic
sectors, geographical location, currency and maturity
b) Target market within each lending segment, preferred level of diversification/ concentration.
c) Pricing strategy.
2.2.4 It is essential that banks give due consideration to their target market while devising credit
risk strategy. The credit procedures should aim to obtain an indepth understanding of the banks
clients, their credentials & their businesses in order to fully know their customers.
2.2.6 The senior management of the bank should develop and establish credit policies and credit
administration procedures as a part of overall credit risk management framework and get those
approved from board. Such policies and procedures shall provide guidance to the staff on various
types of lending including corporate, SME, consumer, agriculture, etc. At minimum the policy
should include
a) Detailed and formalized credit evaluation/ appraisal process.
b) Credit approval authority at various hierarchy levels including authority for approving
exceptions.
c) Risk identification, measurement, monitoring and control
d) Risk acceptance criteria
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
92
Organizational Structure.
2.3.1 To maintain banks overall credit risk exposure within the parameters set by the
board of directors, the importance of a sound risk management structure is second to none. While
the banks may choose different structures, it is important that such structure should be
commensurate with institutions size, complexity and diversification of its activities. It must
facilitate effective management oversight and proper execution of credit risk management and
control processes.
2.3.2 Each bank, depending upon its size, should constitute a Credit Risk Management
Committee (CRMC), ideally comprising of head of credit risk management Department, credit
department and treasury. This committee reporting to banks risk management committee should
be empowered to oversee credit risk taking activities and overall credit risk management
function. The CRMC should be mainly responsible for
a) The implementation of the credit risk policy / strategy approved by the Board.
b) Monitor credit risk on a bank-wide basis and ensure compliance with limits approved
by the Board.
c) Recommend to the Board, for its approval, clear policies on standards for presentation
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
93
2.3.3. Ideally, the banks should institute a Credit Risk Management Department (CRMD).
Typical functions of CRMD include:
a) To follow a holistic approach in management of risks inherent in banks portfolio and ensure
the risks remain within the boundaries established by the Board or Credit Risk Management
Committee.
b) The department also ensures that business lines comply with risk parameters and prudential
limits established by the Board or CRMC.
c) Establish systems and procedures relating to risk identification, Management Information
System, monitoring of loan / investment portfolio quality and early warning. The department
would work out remedial measure when deficiencies/problems are identified.
d) The Department should undertake portfolio evaluations and conduct comprehensive studies on
the environment to test the resilience of the loan portfolio.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
94
strategy of the institution. Before allowing a credit facility, the bank must make an assessment of
risk profile of the customer/transaction. This may include
a) Credit assessment of the borrowers industry, and macro economic factors.
b) The purpose of credit and source of repayment.
c) The track record / repayment history of borrower.
d) Assess/evaluate the repayment capacity of the borrower.
e) The Proposed terms and conditions and covenants.
f) Adequacy and enforceability of collaterals.
g) Approval from appropriate authority
Limit setting
2.4.7 An important element of credit risk management is to establish exposure limits for single
obligors and group of connected obligors. Institutions are expected to develop their own limit
structure while remaining within the exposure limits set by State Bank of Pakistan. The size of
the limits should be based on the credit strength of the obligor, genuine requirement of credit,
economic conditions and the institutions risk tolerance. Appropriate limits should be set for
respective products and activities. Institutions may establish limits for a specific industry,
economic sector or geographic regions to avoid concentration risk.
Credit Administration.
2.5.1 Ongoing administration of the credit portfolio is an essential part of the credit
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
95
process. Credit administration function is basically a back office activity that support and control
extension and maintenance of credit. A typical credit administration unit performs following
functions:
a. Documentation. It is the responsibility of credit administration to ensure completeness of
documentation (loan agreements, guarantees, transfer of title of collaterals etc) in accordance
with approved terms and conditions. Outstanding documents should be tracked and followed up
to ensure execution and receipt.
b. Credit Disbursement. The credit administration function should ensure that the loan
application has proper approval before entering facility limits into computer systems.
Disbursement should be effected only after completion of covenants, and receipt of collateral
holdings. In case of exceptions necessary approval should be obtained from competent
authorities.
c. Credit monitoring. After the loan is approved and draw down allowed, the loan should be
continuously watched over. These include keeping track of borrowers compliance with credit
terms, identifying early signs of irregularity, conducting periodic valuation of collateral and
monitoring timely repayments.
d. Loan Repayment. The obligors should be communicated ahead of time as and when the
principal/markup installment becomes due. Any exceptions such as non-payment or late payment
should be tagged and communicated to the management. Proper records and updates should also
be made after receipt.
e. Maintenance of Credit Files. Institutions should devise procedural guidelines and standards
for maintenance of credit files. The credit files not only include all correspondence with the
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
96
borrower but should also contain sufficient information necessary to assess financial health of the
borrower and its repayment performance. It need not mention that information should be filed in
organized way so that external / internal auditors or SBP inspector could review it easily.
f. Collateral and Security Documents. Institutions should ensure that all security documents
are kept in a fireproof safe under dual control. Registers for documents should be maintained to
keep track of their movement. Procedures should also be established to track and review relevant
insurance coverage for certain facilities/collateral. Physical checks on security documents should
be conducted on a regular basis.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
97
Capital Structure
Present and future Cash flows
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
98
Given below are some key indicators that depict the credit quality of a loan:
a. Financial Position and Business Conditions. The most important aspect about an obligor is
its financial health, as it would determine its repayment capacity. Consequently institutions need
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
99
carefully watch financial standing of obligor. The Key financial performance indicators on
profitability, equity, leverage and liquidity should be analyzed.
b. Conduct of Accounts. In case of existing obligor the operation in the account would give a
fair idea about the quality of credit facility. Institutions should monitor the obligors account
activity, repayment history and instances of excesses over credit limits. For trade financing,
institutions should monitor cases of repeat extensions of due dates for trust receipts and bills.
c. Loan Covenants. The obligors ability to adhere to negative pledges and financial covenants
stated in the loan agreement should be assessed, and any breach detected should be addressed
promptly.
d. Collateral valuation. Since the value of collateral could deteriorate resulting in unsecured
lending, banks need to reassess value of collaterals on periodic basis. The frequency of such
valuation is very subjective and depends upon nature of collaterals.
Risk review
2.8.1 The institutions must establish a mechanism of independent, ongoing assessment of credit
risk management process. All facilities except those managed on a portfolio basis should be
subjected to individual risk review at least once in a year. The results of such review should be
properly documented and reported directly to board, or its sub committee or senior management
without lending authority. The purpose of such reviews is to assess the credit administration
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
100
process, the accuracy of credit rating and overall quality of loan portfolio independent of
relationship with the obligor.
2.8.2 Institutions should conduct credit review with updated information on the obligors
financial and business conditions, as well as conduct of account. Exceptions noted in the credit
monitoring process should also be evaluated for impact on the obligors creditworthiness. Credit
review should also be conducted on a consolidated group basis to factor in the business
connections among entities in a borrowing group.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
101
1.2 However, consistent with the policy of liberalization and financial sector reforms, several
indirect measures to regulate bank credit such as exposure norms for lending to individual/group
borrowers, prudential norms for income recognition, asset classification and provisioning for
advances, capital adequacy ratios, etc. were introduced by RBI and greater operational freedom
has been provided to banks in dispensation of credit.
1.3 Banks are now expected to lay down, through their boards, transparent policies and
guidelines for credit dispensation, in respect of each broad category of economic activity,
keeping in view the credit exposure norms and various other guidelines issued by the
Reserve Bank of India from time to time. Some of the currently applicable guidelines are
detailed in the following paragraphs.
The assessment of working capital requirement of borrowers, other than SSI units, requiring fund
based working capital limits up to Rs.1.00 crore and SSI units requiring fund based working
capital limits up to to Rs.5.00 crore from the banking system may be made on the basis of their
projected annual.
2.2 In accordance with these guidelines, the working capital requirement is to be assessed at
25% of the projected turnover to be shared between the borrower and the bank, viz. borrower
contributing 5% of the turnover as net working capital (NWC) and bank providing finance at a
minimum of 20% of the turnover.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
102
2.3 The banks may, at their discretion, carry out the assessment based on projected turnover basis
or the traditional method. If the credit requirement based on traditional production/processing
cycle is higher than the one assessed on projected turnover basis, the same may be sanctioned, as
borrower must be financed up to the extent of minimum 20 per cent of their projected annual
turnover.
2.5 The borrowers would be required to bring in 5 per cent of their annual turnover as margin
money. In other words, 25 per cent of the output value should be computed as working capital
requirement, of which at least four-fifth should be provided by the banking sector, the balance
one-fifth representing the borrower's contribution towards margin for the working capital.
2.6 Drawals against the limits should, however, be allowed against the usual safeguards so as to
ensure that the same are used for the purpose intended. Banks will have to ensure regular and
timely submission of monthly statements of stocks, receivables, etc., by the borrowers and also
periodical verification of such statements vis--vis physical stocks by their officials.
Working Capital Requirements ABOVE Rs. 1 crore
3.1 Method of Assessment
3.1.1 The revised guidelines in respect of borrowers other than SSI units, requiring working
capital limits above Rs.1 crore and for SSI units requiring fund based working capital limits
above Rs.5 crore, from the banking system bestow greater level of flexibility to the primary
(urban) co-operative banks in their day-to-day operations without diluting the prudential norms
for lending as prescribed by Reserve Bank of India.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
103
3.1.2 The earlier prescription regarding Maximum Permissible Bank Finance (MPBF), based on
a minimum current ratio of 1.33:1, recommended by Tandon Working Group has been
withdrawn. Banks are now free to decide on the minimum current ratio and determine the
working capital requirements according to their perception of the borrowers and their credit
needs.
3.1. 3 .Banks may evolve an appropriate system for assessing the working capital credit needs of
borrowers whose requirement are above Rs.1 crore. Banks may adopt any of the under-noted
methods for arriving at the working capital requirement of such borrowers.
a). The turnover method, as prevalent for small borrowers may be used as a tool of assessment
for this segment as well,
b). Since major corporates have adopted cash budgeting as a tool of funds management, banks
may follow cash budget system for assessing the working capital finance in respect of large
borrowers.
c). The banks may even retain the concept of the MPBF with necessary modifications.
3.2 Norms for Inventory/Receivables
3.2.1 In order to provide flexibility in the assessment of credit requirements of borrowers based
on a total study of borrowers' business operations, i.e., taking into account the
production/processing cycle of the industry as well as the financial and other relevant parameters
of the borrower, the banks have also been permitted to decide the levels of holding of each item
of inventory as also of receivables, which in their view would represent a reasonable build-up of
current assets for being supported by bank finance.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
104
3.2.2. Reserve Bank of India no longer prescribes detailed norms for each item of inventory as
also of receivables.
3.3 Classification of Current Assets and Current Liabilities
3.3.1 With the withdrawal of MPBF, inventory norms and minimum current ratio, the
classification of current assets and current liabilities ceases to be mandatory. The banks may
decide on their own as to which items should be included for consideration as current assets or
current liabilities.
3.3.2 Banks may also consider evolving suitable internal guidelines for accepting the projections
made by their borrowers relating to the item "Sundry Creditors (Goods)" appearing as an item
under "Other Current Liabilities" in the balance sheet.
3.4 Bills Discipline
In respect of borrowers enjoying fund-based working capital credit limits of Rs. 5 crore and more
from the banking system, the banks are required to ensure that the book-debt finance does not
exceed 75 per cent of the limits sanctioned to borrowers for financing inland credit sales. The
remaining 25 per cent of the credit sales may be financed through bills to ensure greater use of
bills for financing sales.
3.5 Grant of Ad hoc Limits
To meet the contingencies, banks may decide on the quantum and period for granting ad hoc
limits to the borrowers based on their commercial judgment and merits of individual cases.
While granting the ad hoc limits the banks must ensure that the aggregate credit limits (inclusive
of ad hoc limits) do not exceed the prescribed exposure ceiling.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
105
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
106
crore and above where it has participated under consortium/syndication, it should ensure strict
compliance with the under-noted guidelines.
3.9.2 Loan Component and Cash Credit Component
i.
Banks may change the composition of working capital by increasing the cash credit
component beyond 20 per cent or to increase the loan component beyond 80 per cent, as
the case may be, if they so desire.
ii.
Banks are expected to appropriately price each of the two components of working capital
finance, taking into account the impact of such decisions on their cash and liquidity
management.
iii.
If a borrower so desires, higher loan component can be granted by the bank; this would
entail corresponding pro-rata reduction in the cash credit component of the limit.
iv.
In the case of borrowers with working capital (fund based) credit limit of less than Rs. 10
crore, banks may persuade them to go in for the Loan System by offering an incentive in
the form of lower rate of interest on the 'loan component' as compared to the 'cash credit
component' The actual percentage of 'loan component' in these cases may be settled by
the bank with its borrower clients.
v.
In respect of certain business activities which are cyclical and seasonal in nature or have
inherent volatility, the strict application of loan system may create difficulties for the
borrowers. Banks, may with the approval of their respective Boards, identify such
business activities which may be exempt from the loan system of credit delivery.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
107
The release of ad hoc/additional credit for meeting temporary requirements may be considered
by the financing bank only after the borrower has fully utilized/exhausted the existing limit.
3.9.4. Sharing of Working Capital Finance
i.
The ground rules for sharing of cash credit and loan components may be laid down by
the consortium, wherever formed, subject to the stipulations contained in Para. 3.9.2
above.
ii.
The level of individual bank's share shall be governed by the norm for single / group
borrowers credit exposure.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
108
Export credit limit would be allowed in the form hitherto granted. The bifurcation of the working
capital limit into loan and cash credit components, as stated in paragraph 3.9.2 (i) above, would
be effected after excluding the export credit limits (pre-shipment and post-shipment).
3.9.9 Bills Limit
Bills limit for inland sales may be fully carved out of the 'loan component'. Bills limit also
includes limits for purchase of third party (outstation) cheques/bank drafts. Banks must satisfy
themselves that the bills limit is not mis-utilized.
3.9.10 Renewal/Roll-over of Loan Component
The loan component , may be renewed/rolled over at the request of the borrower. However,
banks may lay down policy guidelines for periodical review of the working capital limit and the
same may be scrupulously adhered to.
3.911 Provision for Investing Short Term Surplus Funds of Borrowers
The banks, at their discretion, may permit the borrowers to invest their short term/temporary
surpluses in short-term money market instruments like Commercial Paper (CP), Certificates of
Deposit (CDs) and in Term Deposit with banks, etc.
3.9.12 Applicability
The loan system would be applicable to borrower accounts classified as 'standard' or 'substandard'.
4.0 Credit Administration
4.1 No Objection Certificate
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
109
The primary (urban) co-operative banks should not finance a borrower already availing credit
facility from another bank without obtaining a 'No Objection Certificate' from the existing
financing bank.
4.2 Opening of Current Accounts
4.2.1 Keeping in view the importance of credit discipline for reduction in NPA levels at the time
of opening of current accounts banks should:
i.
insist on a declaration from the account holder to the effect that he is not enjoying any
credit facility with any other commercial bank or obtain a declaration giving particulars
of credit facilities enjoyed by him with any other commercial bank/s.
ii.
ascertain whether he/she is a member of any other co-operative society/bank; if so, the
full details thereof such as name of the society/bank, number of shares held, details of
credit facilities, such as nature, quantum, outstanding, due dates etc should be obtained.
4.2.2 Further, in case he/she is already enjoying any credit facility from any other
commercial/co-operative bank, the bank opening a current account should duly inform the
concerned lending bank(s) and also specifically insist on obtaining a "No Objection Certificate"
from them. In case of a prospective customer who is a corporate or large borrower enjoying
credit facilities from more than one bank, the banks may inform the consortium leader, if under
consortium, and the concerned banks, if under multiple banking arrangement.
4.3 Certification of Accounts of Non-Corporate Borrowers by Chartered Accountants
As per the Income Tax Act, 1961, filing of audited balance sheet and profit & loss account is
mandatory for certain types of non-corporate entities. Therefore, the banks must insist on the
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
110
audited financial statements from the borrowers enjoying large limits; since such borrowers
would, in any case, be submitting audit certificate to the income-tax authorities, based on audit of
their books of accounts by a Chartered Accountant.
CHAPTER EIGHT
Reference No.:
Particulars
Projected
2006
2005
2004
75.00
0.00
53.00
22.00
60.00
0.00
42.00
18.00
50.00
0.00
35.00
15.00
45.00
0.00
33.00
12.00
1.44
0.00
1.44
20.56
0.00
0.00
0.00
1.00
5.00
14.56
0.00
14.56
1.44
0.00
1.44
16.56
0.00
0.00
0.00
1.00
5.00
10.56
0.00
10.56
1.44
0.00
1.44
13.56
0.00
0.00
0.00
1.00
5.00
7.56
0.00
7.56
1.44
0.00
1.44
10.56
0.00
0.00
0.00
1.00
4.00
5.56
0.00
5.56
2006
2005
2004
0.20
0.00
15.36
0.00
0.50
0.00
11.00
0.00
1.00
0.00
17.00
0.00
Particulars
Current Asset
Cash in Hand
Cash at Bank
Accounts Receivable
Projected
0.76
0.00
23.80
0.00
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
111
Inventory/Stock
Advance Deposit
60.00
55.00
52.06
58.56
0.00
0.00
0.00
0.00
Prepaid Expenses
0.00
0.00
0.00
0.00
0.00
84.56
0.00
70.56
0.00
63.56
0.00
76.56
103.00
0.00
103.00
0.00
0.00
0.00
0.50
103.00
0.00
103.00
0.00
0.00
0.00
0.50
103.00
0.00
103.00
0.00
0.00
0.00
0.50
103.00
0.00
103.00
0.00
0.00
0.00
0.50
Acc. Depriciation
0.00
0.00
0.00
0.00
0.50
0.00
0.50
0.00
0.50
0.00
0.50
0.00
Acc. Depriciation
0.00
0.00
0.00
0.00
0.00
103.50
188.06
0.00
103.50
174.06
0.00
103.50
167.06
0.00
103.50
180.06
0.00
0.00
0.00
0.00
20.00
33.33
5.00
33.33
5.00
33.33
15.00
33.33
0.00
0.00
0.00
0.00
0.00
53.33
0.00
38.33
0.00
38.33
0.00
48.33
0.00
0.00
0.00
53.33
0.00
0.00
0.00
38.33
0.00
0.00
0.00
38.33
0.00
0.00
0.00
48.33
Capital/Paid-up Capital
96.49
112.05
115.61
126.17
Retained Earnings
38.24
23.68
13.12
5.56
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
112
Reserves
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
134.73
135.73
128.73
131.73
188.06
174.06
167.06
180.06
Major Ratios
Projected
2006
2005
2004
0.29
0.19
0.27
0.08
0.11
0.30
0.18
0.28
0.06
0.08
0.30
0.15
0.27
0.05
0.06
0.27
0.12
0.23
0.03
0.04
1.59
0.46
1.84
0.41
1.66
0.30
1.58
0.37
0.72
0.40
0.58
0.34
0.48
0.30
0.43
0.25
2.40
115.83
1.86
93.44
1.98
80.30
1.59
137.89
413.21
477.98
542.91
647.71
97.33
30.42
36.50
121.67
0.40
0.28
0.28
0.22
0.30
0.23
0.37
0.27
0.51
2.91
0.41
2.11
0.33
1.51
0.26
1.39
Profitability Ratios:
Gross Profit Margin (%)
Net Profit Margin (%)
Operating Profit Margin (%)
Return on Assets (%)
Return on Equity (%)
Liquidity Ratios:
Current Ratio
Quick Ratio
Asset Utilization Ratios:
Sales to Fixed Assets (times)
Sales to Total Assets (times)
2006
2005
Change (+/-)
15.36
55.00
0.00
0.00
0.00
5.00
33.33
11.00
52.06
0.00
0.00
0.00
5.00
33.33
10.56
0.00
0.00
(4.36)
(2.94)
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
113
0.00
0.00
0.00
3.26
Investing Activities
Change in Land & Building
Change in Plant and Machinery
103.00
0.00
103.00
0.00
0.00
0.00
0.50
0.50
0.00
0.00
0.00
0.00
0.00
0.00
0.00
112.05
0.00
0.00
0.00
115.61
0.00
0.00
0.00
(3.56)
0.00
(3.56)
(0.30)
Opening Balance
(Cash Withdrawal) /
injection
Ending Balance
0.50
Cash
0.00
0.20
Date: 11.02.2006
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
114
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XXXXXXXXXXXX
Aggregate Score:
31.12.2006
X
65.50
Risk Grading:
Marginal/W
atch List
Completed by (RM/SRM)
Approved by (CO/SCO)
Numeric Grade
Grade
Superior
2
3
4
Good
Acceptable
Marginal/Watchlist
5
6
7
8
Special Mention
Substandard
Doubtful
Bad/Loss
Score
Fully cash covered, secured by
Bank
SUP Government/International
Guarantee
Short
85+
75-84
65-74
GD
ACCPT
MG/W
L
SM
SS
DF
BL
55-64
45-54
35-44
<35
Weight
50%
10%
5%
Parameter
< 0.25 x
5.00
0.32
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
Score
Obtained
4.5
115
5%
A-2 Liquidity
A-2.1Current Ratio (x) -Times
10%
5%
5%
A-3 Profitability
A-3.1 Operating Profit Margin (%)
(Operating Profit/Sales) X 100
0.26 to 0.35 x
0.36 to 0.50 x
0.51 to 0.75 x
0.76 to 1.25 x
1.26 to 2.00 x
2.01 to 2.50 x
2.51 to 2.75 x
> 2.75
< 0.25
0.26 to 0.35 x
0.36 to 0.50 x
0.51 to 0.75 x
0.76 to 1.25 x
1.26 to 2.00 x
2.01 to 2.50 x
2.51 to 2.75 x
> 2.75
4.50
4.25
4.00
3.50
3.25
3.00
2.50
0.00
5.00
4.50
4.25
4.00
3.50
3.25
3.00
2.50
0.00
> 2.74
2.50 to 2.74 x
2.00 to 2.49 x
1.50 to 1.99 x
1.10 to 1.49 x
0.90 to 1.09 x
0.80 to 0.89 x
0.70 to 0.79 x
< 0.70
> 2.00
1.75 to 2.00 x
1.50 to 1.74 x
1.25 to 1.49 x
1.00 to 1.24 x
0.75 to 0.99 x
0.50 to 0.74 x
0.25 to 0.49 x
Less than 0.25
> 25%
23% to 25%
20% to 22%
17% to 19%
14% to 16%
11% to 13%
8% to 10%
0.24
5.00
4.50
4.25
4.00
3.50
3.25
3.00
2.50
0.00
5.00
4.50
4.25
4.00
3.50
3.25
3.00
2.00
0.00
1.69
0.36
5.00
4.50
4.00
3.50
3.25
3.00
2.50
26.06%
20%
5%
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
116
< 8%
Criteria
A-3.2 Net Profit Margin (%)
5%
5%
A-4 Coverage
A-4.1 Interest Coverage () - Times
10%
5%
> 15.00%
13% to 15%
11% to 12%
9% to 10%
7% to 8%
5% to 6%
3% to 4%
< 3%
> 30%
26% to 30%
22% to 25%
18% to 21%
14% to 17%
8% to 13%
5% to 7%
< 5%
> 15.00%
13% to 15%
11% to 12%
9% to 10%
7% to 8%
5% to 6%
2% to 4%
< 2%
5.00
4.50
4.00
3.50
3.25
3.00
2.50
0.00
5.00
4.50
4.00
3.50
3.25
3.00
2.50
0.00
5.00
4.50
4.00
3.50
3.25
3.00
2.00
0.00
15.03%
Score
Obtained
5
4.56%
5.96%
> 2.00
1.51 to 2.00
1.25 to 1.50
1.00 to 1.24
< 1.00
> 2.00
1.51 to 2.00
1.25 to 1.50
1.00 to 1.24
< 1.00
5.00
4.00
3.00
2.00
0.00
5.00
4.00
3.00
2.00
0.00
50.00
1.67
0.33
> 60.00
4.00
0.60
30.00 59.99
3.50
10.00 29.99
3.00
5.00 - 9.99
2.00
Weight
5%
5%
EBITDA/(Total Interest+CMLTD)
0.00
Parameter
18%
4%
32.50
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
117
total
sales.
numbers.
Preferably
audited
3%
2%
1.00
0.00
> 10 Years
6 - 10 Years
3.00
2.00
2 - 5 Years
1.00
< 2 Years
0.00
Favorable
2.00
Stable
1.50
Slightly Uncertain
1.00
0.00
Weight
share,
2%
3%
2.50 - 4.99
< 2.50
2%
demand
2%
Parameter
C. Management Risk
C-1 Experience
Total length of experience of the
senior management in the related
line of business.
Slightly Uncertain
Locally available
2.00
1.00
0.50
Scarce
0.00
Strong (10%+)
3.00
2.00
Moderate (1%-5%)
1.00
No Growth (<1%)
0.00
Dominant Player
2.00
Moderately Competitive
1.00
Highly Competitive
0.00
Difficult
2.00
Average
1.00
Easy
0.00
above 10
Score
Obtained
Partially import
dependent
Strong (10%+)
Highly Competitive
Easy
18.00
8.00
12%
5
5.00
610 years
3.00
15 years
2.00
610 years
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
118
C-2 Trackrecord
No experience
Very Good
0.00
2.00
Moderate
1.00
Poor
0.50
Marginal
0.00
Ready Succession
3.00
2.00
1.00
Succession in question
0.00
Very Good
2.00
Moderate
1.00
Poor
0.50
Regular Conflict
0.00
Criteria
D. Security Risk
D-1 Security Coverage (Primary)
Ready Succession
Very Good
12.00
Weight
Parameter
10.00
Score
Obtained
10%
4%
Fully
covered
by
underlying
assets/substantially
cash
covered
Registered Hypothecation
(1st
Charge/Pari
passu
Charge)
Simple hypothecation
Negative lien on assets
Very Good
4%
Registered
Hypothecation (1st
Charge/Pari passu
Charge)
R/M on Municipal
corporation/Prime
Area property
No security
R/M
on
Municipal
corporation/Prime
Area
property
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
119
2%
No collateral
Personal Guarantees or
Corporate Guarantee with
average financial strength
No support/guarantee
Personal
Guarantees or
Corporate
Guarantee with
average financial
strength
10
10%
Criteria
E-3 Compliance of Covenants
10%
5%
2%
Weight
2%
1%
5.00
4.00
Accounts
having
satisfactory dealings with
some late payments.
2.00
Frequent
Irregular
account
0.00
Past dues
dealings
&
in
2.00
1.50
1.00
0.00
Accounts
having
satisfactory
dealings with some
late payments.
80%+
Full Compliance
2.00
Some Non-Compliance
1.00
No Compliance
0.00
1.00
Full Compliance
Personal accounts
of the key business
Sponsors/
Principals
are
maintained in the
bank,
with
significant deposits
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
Score
Obtained
2
120
No depository relationship
Total Score- Relationship Risk
0.00
10.00
7.00
100.00
65.50
Note: All calculations should be based on annual financial statements of the borrower (audited preferred).
Working Notes:
Gross profit margin: gross profit/ sales
Net profit margin : net profit/ sales
Operating profit margin: operating profit / sales
Return on asset : net profit/ total asset
Return on equity: profit after tax/ net worth
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
121
CHAPTER NINE
Findings and Conclusion
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
122
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
123
# Government has taken reforming measures and amended bank Companys Act,1991 to meet
the demand of open market economy.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
124
9.7. Recommendation:
9.7.1 A good plan is the half done of a job. so adoption of planning in every event and activity of
banking operations will harness achieving the target. The field of planning may be as follows :
Manpower Planning / HRD
Deposit & Credit Rationality including selection of good borrower.
Remittance & Foreign Exchange Business.
Motivation and Cost effectiveness.
Budgeting
9.7.2
Enforcing credit discipline, disciplining borrowers, bank owners, bank officers and
employees.
9.7.3
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
125
9.7.7
Appropriate measures to develop capital market ( Capital market is not yet properly
structured in the country).
9.7.8
9.7.9 Credit related activities must be guided and supported from top-most hierarchy.
9.8. Conclusion :
A number of prudential Credit Analysis Techniques (reform measures) have been introduced and
economic regulations have been liberalized. The measures aimed at improving financial
discipline depending on the market forces and to improve operational efficiency. But appreciable
change in operational efficiency and management attitudes of banks are yet to be developed.
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
126
The measures so far taken are appropriate and demand continuation and extension. There has
been improvement in the context of financial discipline and workings of the overall financial
system. Increasing competition and adaptation of advanced technology both domestically and
internationally require to upgrade the systems on regular basis to remain competitive. So, It
should be continued the activities in that direction.
It has been demonstrated that financial reform is more successful in countries that already have
relatively strong human capital base. Human capital is invaluable in the financing reform
process, but without a proper incentive system it can not be developed. Service should valued on
the basis of a market-based system. If salaries are not at the proper level, desired personnel
cannot be recruited and retained. If appropriate incentives and training are not given, motivation
and efficiency will be lacking. These are to be seriously taken care of to build up a well-knit and
efficient system.
I wish overall success of the system.
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127
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION
128
BIBLIOGRAPHY
129
CREDIT RISK GRADING- A NEW CONCEPT OF MANAGING CREDIT RISK & LOAN CLASSIFICATION